Thanks to…. Phone ringing: Our client, a Georgia resident, age 68 and desirous of having more cash flow, owns a large tract of timberland in north Georgia. The land has been in the family for years and has a very low basis. He called us today and indicated that he recently had the timber cruised and that a buyer has agreed to &quot;residential cut&quot; the tract and pay our client $1million for the timber. Our guy is ready to sign the contract to sell the timber immediately. With the proceeds, our guy wants to buy either: (1) two &quot;investment&quot; lots on the Cayman Islands; (2) timberland in &quot;Big Sky&quot; country (Montanta); or (3) a rental house on St. Simons Island. Our client has asked us to let him know quickly if there's anything he needs to be aware of and anything he can do to save on taxes before he makes his decision. He then indicated that he may sell his land next year because the acreage stands in a growth corridor for local residential development. Several builders have approached him to gauge his interest in selling the tract. He believes he can get about $4 million next year if he sells the tract in gross. He is looking to sell for several reasons. First, he is 68 years old and wants to stop paying taxes on the non‑cash‑flowing land. It's a drain on his resources and he'd like to convert the land into something more productive. Second, in retirement, he needs and wants the cash flow. And third, his buddies have been trying to get him involved in a real estate deal that they've been putting together for a number of months. The deal involves the purchase of land on State Bridge Road in Alpharetta and the construction of a strip center on the land. Land cost: $3.0 million. Anticipated project cost: $15.0 million. To make the deal work, the land must be acquired in January and construction would begin immediately. Our client wants to be involved in the deal and yet knows from talking to local builders that the sale of his timberland will likely not close until May or June of next year. He's looking for our advice....
Not all exchanges are simultaneous transactions. Discuss Starker. (Under the 1984 TRA), 1031(a)(3) added specific timing rules to resolve uncertainties of Starker case. 602 F.2d 1341 (1979)
Mention final regs effective 2/1/02 that narrow definition of disqualified person to allow banks and bank affiliates that are part of a controlled group that includes investment banking and brokerage firms to act as QIs without being considered disqualified persons
IRC Section 1031(b) provides (essentially): (b) Gain From Exchanges Not Solely in Kind- If an exchange would be within the provisions of subsection (a)…, if it were not for the fact that the property received in exchange consists not only of (Like-kind property which can be received without recognition of gain), but also of OTHER PROPERTY OR MONEY, then the gain… to the recipient shall be recognized… but in an amount not in excess of the sum of such money and the FMV of such other property Section 1031 (C) By contrast, by the way, Section 1031(C) provides, with regard to receipt of boot in an exchange that involves losses, that NO LOSS SHALL BE RECOGNIZED.
EXAMPLE 1: Real estate with a basis of $5,000 is exchanged for real estate with a fair market value of $6,000 and cash in the amount of $2000 in a transaction that would qualify for non-recognition of gain under Code Section 1031(a) if it were not for the inclusion of cash as a part of the property received. The realized gain from the transaction is $3,000, but it is recognized only to the extent of the cash received of $2,000.
Consideration that is received in the form of an assumption of a liability is considered as other property or money and is therefore boot. <7> EXAMPLE 2: Sally exchanged an apartment house with an adjusted basis of $500,000 and on which there was a $150,000 mortgage with Harry for $50,000 in cash and another apartment house with a fair market value of $600,000. Harry assumed the mortgage on Sally's apartment house. The total consideration received by Sally was $800,000 ($600,000 in value of the apartment house she received, $50,000 in cash, and $150,000 in the assumption of the mortgage by Harry), and her realized gain on the transaction was therefore $300,000 (the $800,000 received less her adjusted basis of $500,000). Recognition of the gain, however, is limited to $200,000, the amount of boot ($50,000 in cash and $150,000 in the assumption of the liability). Where each party to an exchange assumes a liability of the other party, such consideration given is offset against such consideration received. Reg. Section 1.1031(b)-1(c) . The Tax Court has noted that where liabilities are relieved and assumed on both sides of an exchange, they are netted against each other in determining the extent, if any, to which taxable boot has been received. Garcia v. Commissioner , 80 T.C. 491 (1983). Cash paid by Taxpayer in exchange also netted against boot, as is new debt incurred by T (See PLR 9853028) COMPLIANCE TIP: A taxpayer who receives boot in an exchange or otherwise recognizes gain on a like-kind exchange must report the gain on either Form 4797, Sales of Business Property, or 6252, Installment Sale Income, whichever applies, as well as reporting the exchange on Form 8824, Like-Kind Exchanges.
Under check-the-box regs. under §7701, entity disregarded for federal income tax purposes PLRs support §1031 non-recognition treatment of exchanges utilizing single member LLCs. PLR 9807013 and 9751012 – since single owner LLC is disregarded as an entity, transactions viewed as if the taxpayer had itself directly received the replacement property, therefore satisfying the holding requirement of Section 1031. Single member LLC is also desirable from the taxpayer’s perspective for liability purposes. Keeps taxpayer out of direct chain of title (improving T’s risk profile with regard to hazardous materials, personal injury and structural defects risks associated with the ownership and operation of real property. Of course, normal company formalities should be observed in order to counter veil piercing arguments in litigation…. LLC should be take steps to avoid having company veil pierced: 1. Establish separate bank account; 2. Avoid commingling personal assets with LLC assets; 3. Document loans and other activities between members and the LLC; and 4. Insure that transactions between members and the LLC are conducted at arms-length.
Along those lines, what if your client’s 1031 exchange is about to blow up because of unanticipated action: 1. The buyer of your client’s property (to be relinquished) walks on the purchase transaction, and yet the purchase of the replacement property is scheduled to close in the next couple weeks. What if, instead, your client needs to close on the acquisition of replacement property very quickly (like my client Boswell Scadds) so as not to lose a great deal? (And yet your client has not yet sold the property to be relinquished) In such instances the answer may rest with the reverse exchange . In its simplest form, a reverse exchange may look like a deferred exchange conducted backwards, with the replacement property being acquired before the relinquished property has been sold.
REV PROC 2000-37 notes (continued) The Service has granted taxpayers some significant latitude in structuring arrangements within the safe harbor. The Rev Proc lists certain “Permissible Agreements” which, if entered into, will not cause property to fail to be treated as being held in a QEAA regardless of whether such arrangements contain terms that typically would result from arm’s length bargaining between unrelated parties with respect to such arrangements. Permissible agreements include: An EAT that satisfies the reqts of the QI safe harbor at 1.1031(k)-1(g)(4) may enter into an exchange agreement with T to serve as QI in a simultaneous or deferred exchange of the property under Section 1031; (One call does it all!) T or a disqualified person guarantees some or all the obligations of the EAT , including secured or unsecured acquisition indebtedness, or indemnifies the EAT against costs and expenses; T or a disqualified person loans or advances funds to the EAT or guarantees a loan or advance to the EAT; (EAT needs no money!) The property is leased by the EAT to T or a disqualified person; (T controls the property!) T or a disqualified person manages the property, supervises improvement of the property, acts as a contractor, or otherwise provides services to the EAT with respect to the property ; T and the EAT enter into agreements or arrangements relating to the purchase or sale of the property , including puts or calls at fixed or formula prices, effective for a period not in excess of 185 days from the date of transfer of QIO of property to the EAT; (both parties protected) T and the EAT enter into agreements or arrangements providing that any variation in the value of a relinquished property from the estimated value on the date of EAT’s receipt of title to the date of disposition be settled up between the parties at time of disposition (EAT protected against changes in value) IMPORTANT FOOTNOTE! If all reqts of the safe harbor are not met, the exchange is NOT automatically disqualified for 1031 purposes. The Rev Proc simply doesn’t apply and the treatment of the EAT as owner for fedl income tax purps and the proper treatment of transactions entered into between the parties will be made without regard to the Rev Proc.
At final settlement under this scenario, QI releases money under its control to the person responsible for making all disbursements at closing. As part of closing, the AT delivers a deed to the Replacement Property to the Taxpayer as and when the lender’s and Taxpayer’s loans are repaid. Excess cash, if any, is delivered to the Taxpayer as cash boot. When the exchange has been completed, the taxpayer has exchanged old property for new property of a like-kind, monies have changed hands through an intermediary and, presumably, some or all of the taxpayer’s gain has been successfully deferred. There are a number of structural variations on the theme described above that may be productively employed depending on individual taxpayer circumstances. It is possible, for instance, to
In the recent case of Smalley v. Comm’r, 116 T.C. 450 filed June 14, 2001 (and ably and successfully argued by this firm’s very own David Aughtry on behalf of the taxpayer) the Court addressed the issue of whether a limited right to cut and remove standing timber from a tract of land could be exchanged by the taxpayer for fee simple title in several parcels of Georgia timberland in a transaction that would qualify for nonrecognition of gain under Section 1031. The IRS argued that a 2 year cutting contract was personal property and not of like-kind to the replacement real property. Characterizing the transaction as an exchange of timber for “timber and land”, the Smalleys argued that both interests, under GA law, are characterized as real property interests. While acknowledging that, under GA law, the prevailing view appears to be that a conveyance of standing timber, to be severed by the buyer, generally constitutes a transfer of real property, Smith v. Alexander & Bland 148 SE 98 (Ga 1929) McLendon Bros. V. Finch 58 SE 690, 691-692 (Ga 1909) McRae v. Stillwell, 36 S.E. 604 (Ga. 1900) the Court also noted that not every exchange of real property interests meets the Section 1031 like-kind requirements and that GA State law “is less than a seamless web of jurisprudence”… on the issue. Intentionally side-stepping the legal issue of whether the like-kind requirement was resolved, the Court nonetheless ruled in favor of the Taxpayer, citing the Taxpayer’s “bona fide intent that the subject transaction would meet the like-kind requirement taking into account that it constituted an exchange of realty for realty.” Is it now a settled issue in Georgia that standing timber may be exchanged under 1031 for fee simple interests in other land? IS THAT YOUR FINAL ANSWER? I’m going to defer, use my “lifeline” and call David Aughtry….
This recent Rev Proc clarifies conditions under which the IRS will consider requests for rulings that a UFI in rental real property is not an interest in a business entity. Though not a safe harbor, it is likely that compliance with the Rev Procs guidelines will increase the likelihood that UFIs in rental real estate will be considered interests in the real estate itself rather than an interest in a business entity, thus permitting tax-deferred like-kind exchange treatment for transactions involving UFIs. The Rev Proc applies to almost all rental real property (other than certain mineral properties defined in Section 614) including but not limited to prepackaged tenancy in common programs. UFI structures have been developed over the past decade to afford taxpayers flexibility and more attractive options when exchanging property under Section 1031. By making available UFIs under prepackaged programs, promoters have touted the following benefits to taxpayers: Timing flexibility- exchanges involving the pruchase of UFIs as replacement property may be conducted at almost any time and in virtually any amount; Diversification- Ability to exchange one property for a larger one or for several properties; Ability to increase depreciation; Ability to improve the quality of proerty invested in; and Decrease management responsibility. The Rev Proc detailed 15 conditions that must be satisfied before IRS will consider issuing a private ruling on a UFI program. They include: 1. Co-owners must hold legal title as tenants-in-common under local law. The number of co-owners cannot exceed 35 (husband and wife being treated as a single person). The TIC cannot file a partnership or corporate tax return or hold itself out as a business entity. Major decisions such as sale, lease, and financing must be unanimous. For other actions, a majority vote is sufficient. Each co-owner must be able to transfer or mortgage his undivided interest without the approval of anyone else. However, the program sponsor may be given a right of first offer. In addition, restrictions on the right to transfer or encumber the interest by a lender in customary commercial lending practice are not prohibited. All revenues and expenses of the property must be shared among co-owners in proportion to their interests. Co-owner activity must be limited to those customarily performed in connection with the ownership of passive real estate. In determining “activity,” all activities of an agent as well as the co-owner are taken into account. The commonly owned property must be subject to a true lease, with rent reflecting the fair rental value of the property. A lender holding a mortgage on the property cannot be related to any co-owner, sponsor, property manager or tenant. Payment for the fractional interest must reflect its fair market value and cannot depend on projected income or profits. We will continue to look for PLRs that speak to the issue in greater detail.
1031 Exchanges In Georgia
Like-Kind Exchanges: Some, Liked by the IRS, Kind to the Taxpayer Presented by: C. Talbot Nunnally, III, Esq. William V. McRae, III, Esq.
Like-Kind Exchanges: Some, Liked by the IRS, Kind to the Taxpayer Our Thanks to: Ron Raitz , President- Real Estate Exchange Services, Inc. Robert J. Waddell , Esq.
“ Gentlemen, this is a football” Vince Lombardi
I.R.C. § 1031 Exchange of Property Held for Productive Use or Investment
I.R.C. § 1031 A Brief History 1918- Income Tax Established 1921- Nonrecognition of gain or loss concept established 1979- Starker case 1984- Identification and acquisition timeframes established
I.R.C. § 1031 A Brief History 1989- Related party rules added; Foreign real property excluded 1990- 761(a) election added 1991- Treas. Reg. §1.1031 adopted 2000- Rev. Proc. 2000-37 2002- Rev. Proc. 2002-22
I.R.C. § 1031(a)(1) <ul><li>Nonrecognition of Gain or Loss From Exchanges Solely in Kind </li></ul><ul><li> (1) In General- No gain or loss shall be recognized… </li></ul>
I.R.C. § 1031(a)(1) <ul><li>Nonrecognition of Gain or Loss From Exchanges Solely in Kind </li></ul><ul><li>(1) In General- No gain or loss shall be recognized… </li></ul>on the exchange of property…
I.R.C. § 1031(a)(1) <ul><li>Nonrecognition of Gain or Loss From Exchanges Solely in Kind </li></ul><ul><li>(1) In General- No gain or loss shall be recognized… </li></ul>on the exchange of property… held for…
I.R.C. § 1031(a)(1) <ul><li>Nonrecognition of Gain or Loss From Exchanges Solely in Kind </li></ul><ul><li>(1) In General- No gain or loss shall be recognized… </li></ul>on the exchange of property… held for… productive use in a trade or business…
I.R.C. § 1031(a)(1) <ul><li>Nonrecognition of Gain or Loss From Exchanges Solely in Kind </li></ul><ul><li>(1) In General- No gain or loss shall be recognized… </li></ul>on the exchange of property… held for… productive use in a trade or business … or for investment …
I.R.C. § 1031(a)(1) <ul><li>Nonrecognition of Gain or Loss From Exchanges Solely in Kind </li></ul>… if … exchanged solely for property of like kind …
§ 1031(a)(2) - Exceptions: <ul><li>Stock in trade or other property held primarily </li></ul><ul><li>for sale </li></ul><ul><li>Stocks, bonds, or notes </li></ul><ul><li>Other securities or evidences of indebtedness </li></ul><ul><li>or interest </li></ul><ul><li>Partnership interests </li></ul><ul><li>Certificates of trust or beneficial interests </li></ul><ul><li>Choses in action </li></ul>
§ 1031- “Boot” <ul><li>$$$ (Money Actually Received) </li></ul><ul><li>Other (Ineligible) Property Received </li></ul>Gain (not loss) recognized to extent of boot received <ul><li>Money “Deemed” Received </li></ul>
§ 1031- “Boot” – Money “Deemed Received” <ul><li>Debt on taxpayer’s property (if paid or otherwise satisfied) </li></ul><ul><li>Debt on taxpayer’s property (if assumed or taken subject to by Transferee) </li></ul><ul><li>except to extent of debt (on Replacement </li></ul><ul><li>Property) assumed by taxpayer </li></ul>
§ 1031- “Boot Netting” Reg. § 1.1031(d)- 2 Cash paid by Taxpayer ? New debt incurred by Taxpayer? Debt assumed or taken “subject to” by Transferee netted against debt assumed or taken subject to by Taxpayer
“Cashing Out”… OK? <ul><li>Borrowing should be a separate and distinct transaction </li></ul><ul><li>Transaction should have </li></ul><ul><li>independent economic </li></ul><ul><li>significance </li></ul><ul><li>Transaction should have a </li></ul><ul><li>legitimate business </li></ul><ul><li>purpose </li></ul>
1031 Exchanges: Problems ? Issue: Many lenders prefer to lend to special purpose entities designed to preclude borrower from filing bankruptcy. Entity organizational documents restrict permitted activities to ownership of collateral
1031 Exchanges: Problems ? Problem: The taxpayer who enters into the exchange must be same taxpayer who receives the replacement property Problem: Taxpayer who contributes replacement property to special purpose entity immediately after an exchange faces “holding” problem
1031 Exchanges: Single Member LLCs Solution: Utilize single member LLC
1031 Exchanges Problem: What if TIMING issues threaten to ruin your client’s exchange ? Solution: The Reverse Exchange